“They take aggressive positions, and they figure that if enough of them take an aggressive position, and there’s billions of dollars at stake, then the IRS is kind of estopped from arguing with them because so much would blow up. And that is called the Wall Street Rule. That is literally the nickname for it.”(1)

Investors in mortgage-backed securities, built on the shoulders of the tax-advantaged Real Estate Mortgage Investment Conduit (“REMIC”), may be facing extraordinary tax losses because of how bankers and lawyers structured these securities.

This calamity is compounded by the fact that those professional advisers should have known that the REMICs they created were flawed from the start. If these losses are realized, those professionals will face suits for damages so large that they could put them out of business. That is, unless the Wall Street Rule is applied.

The issue of REMIC failure for tax purposes is important in at least three contexts:

(1) in any potential effort by the IRS to clean up this industry;

(2) in civil lawsuits brought by REMIC investors against promoters, underwriters, and other parties who pooled mortgages and sold mortgage-backed securities; and

(3) state and federal prosecutors and regulators who consider bringing criminal or civil claims against promoters, underwriters, and other parties who pooled mortgages and sold MBSs.

Even in Dallas, Texas – where I practiced law for 28 years prior to joining the IRS – we had heard of the Wall Street Rule. Some might say that is not surprising because Dallas is just Fort Worth trying to be New York. The truth is that the Wall Street Rule is widely known in the tax world and is not limited to issues that originate from, or arise on, Wall Street. The Wall Street Rule may often be cited with respect to publicly traded securities, but the underlying premises of the Wall Street Rule apply to the tax treatment of a variety of issues and transactions. Therefore, my comments today are not limited to the financial industry or to Wall Street.

There are at least two accepted versions of the Wall Street Rule.

One version is that the IRS cannot attack the tax treatment of any security or transaction if there is a long-standing and generally accepted understanding of its expected tax treatment. This is the “golden oldie” version of the rule.

The second version of the Wall Street Rule is that the IRS is deemed to have acquiesced in the tax treatment of any security or transaction if the dollar amount involved is of sufficient magnitude. This version of the Wall Street rule is primarily premised on the dollars involved and the adverse economic or market impact of any challenge by the IRS. This is the “golden rule” version of the Wall Street Rule.

When I first started practicing law, a senior lawyer asked me if I knew the “golden rule.” I mumbled something about “do unto others as you would have them do unto you.” He immediately corrected me with the real golden rule. He said: “The person with the gold makes the rules.” That pretty well summarizes the “golden rule” version of the Wall Street Rule. If the dollars are big enough, the IRS cannot challenge the tax treatment of a transaction or security because the economic or market impact would be too large.

Sometimes, both versions of the Wall Street Rule are invoked simultaneously. But, any version of the Wall Street Rule ultimately is based on the principle of estoppel by laches. This is an equitable principle holding that a claim or right may not be enforced if the plaintiff delayed too long in making the claim or enforcing the right.

One of the basic legal rules I learned in law school, however, was that there is no estoppel against the King. This basic legal rule applies under the tax law. There is no equitable principle of estoppel by laches against the Commissioner under the tax law. The failure of the IRS to issue published guidance on a transaction, and even the failure of the IRS to raise issues regarding a transaction in audits for many years does not prevent the IRS from questioning the tax treatment of the transaction. As a legal matter, there is no such thing as The Wall Street Rule.

As a lawyer, therefore, I must dismiss the Wall Street Rule, whether I represent the IRS or taxpayers. Taxpayers cannot rely upon the Wall Street Rule, since it is not equitably or legally binding on the IRS. Likewise, the Commissioner may challenge positions taken by taxpayers, however longstanding and however many dollars are at stake.

While it is good tax policy and good tax administration to issue published guidance to inform taxpayers of the IRS’s view of the tax consequences of their transactions, the IRS cannot be expected promptly to identify and respond to all transactions. There are institutional and practical limitations on the ability of the IRS to issue published guidance on each and every transaction or issue. That we aspire to issue more, and more timely, published guidance does not give any credibility to the Wall Street Rule.

Even though the Wall Street Rule is not legally relevant, we cannot ignore the widespread acceptance in the tax world of the Wall Street Rule. The widespread assertion of the Wall Street Rule also tells us something about the attitudes of taxpayers and tax practitioners regarding the self-assessment system.

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The information, reporting, and commentary contained in The Home Equity Theft Reporter are intended solely to provide general information on The Home Equity Theft issues occurring throughout the United States and are based on information sources deemed reliable by the The Home Equity Theft Reporter. This weblog is not intended, nor should it be regarded by the reader, as a solicitation for business. The posts on this site are presented as general research, information and personal opinion of The Home Equity Theft Reporter and are expressly not intended, shall not constitute, and should not be regarded by anyone, as legal advice. No claims, promises or guarantees about the accuracy, completeness or adequacy of the information linked to or from this weblog are contained herein.